The Price System & the Microeconomy

Demand & Supply Curves

Effective Demand

• Definition: The quantity of a good/service an individual is willing and able to purchase over a range of prices over a period.
  • Desire for Product: Must be backed by the ability to pay.
• Important Note: Distinguish between demand and desire for a product.
  • Example: Wanting a Ferrari but can't afford it means no effective demand.

Demand

• Individual Demand: Relationship between individual demand and price.
• Law of Demand: Quantity demanded is inversely proportional to its price.
• Demand Curve: Shows the relationship between quantity demanded and price, assuming all other factors are constant (Ceteris Paribus).

Market Demand

• Definition: Total demand for a product in the market.
• Purpose: Shows relationship between market demand and price.
• Calculation: Sum of individual demands at any given price.

Supply

• Definition: Quantity a producer is willing to offer over a range of prices.
• Law of Supply: Quantity supplied is directly proportional to its price.
• Supply Curve: Relationship between quantity supplied and price, assuming all else constant (Ceteris Paribus).

Market Supply

• Definition: Total supply for a product in the market.
• Purpose: Shows relationship between market supply and price.
• Calculation: Sum of individual supplies at each price.

Shift vs. Movement Along Curve

• Price: Moves along the curve.
• Determinants Change: Shifts the entire curve.

Determinants of Demand

1. Income:
   • Normal Good: Demand rises with income.
   • Inferior Good: Demand falls with income.
2. Price of Other Goods:
   • Substitutes: Alternatives; if price of one rises, the other's demand rises.
   • Complements: Consumed together; if price of one rises, both demands fall.
3. Tastes & Preferences: Advertising influences demand.
4. Speculation: Future price expectations affect demand.
5. Population Characteristics: Size, age, gender affect demand.
6. Income Distribution: Equality influences normal and luxury good demand.

Determinants of Supply

1. Costs of Production: Higher costs reduce supply.
2. Resource Availability: More resources increase supply.
3. Climate: Affects industries like agriculture.
4. Technology: Improvements increase supply.
5. Government Regulation: Can decrease supply.
6. Taxes & Subsidies: Taxes lower, subsidies increase supply.

Price Elasticity, Income Elasticity & Cross Elasticity of Demand

Price Elasticity of Demand (PED)

• Definition: Responsiveness of demand to price changes.
• Types:
  • Perfectly Elastic: Infinite demand change.
  • Elastic: Demand change larger than price change.
  • Inelastic: Demand change smaller than price change.
  • Perfectly Inelastic: No change in demand.

Income Elasticity of Demand (YED)

• Definition: Responsiveness of demand to income changes.
• Types:
  • Inferior Good: Demand falls as income rises.
  • Luxury Good: Demand rises more than income.

Cross Elasticity of Demand (XED)

• Definition: Demand change of one good relative to price change of another.
• Types:
  • Complements: Negative relationship.
  • Substitutes: Positive relationship.

Price Elasticity of Supply

Price Elasticity of Supply (PES)

• Definition: Responsiveness of supply to price changes.
• Factors Influencing:
  1. Time Scale: Long run more elastic.
  2. Spare Capacity: More resources increase elasticity.
  3. Level of Stocks: Storable goods more elastic.
  4. Flexibility of Production: Flexible resources increase elasticity.
  5. Market Entry: Lower barriers increase elasticity.

Interaction of Demand and Supply

Market Equilibrium

• Definition: Point where supply equals demand.
• Disequilibrium: Results in surplus or shortage.

Price Mechanism

• Functions: Rationing, signalling, incentivizing.
  • Rationing: High prices limit demand.
  • Signalling: Prices indicate market needs.
  • Incentivizing: High prices encourage output.

Consumer and Producer Surplus

Consumer Surplus

• Definition: Difference between willingness to pay and actual price.
• Graph Location: Above price, below demand curve.

Producer Surplus

• Definition: Difference between willingness to charge and actual price.
• Graph Location: Below price, above supply curve.

Economic Welfare

• Definition: Total societal benefit from transactions.
• Calculation: Sum of producer and consumer surpluses.

These notes should serve as a comprehensive summary of the key concepts related to the price system, demand and supply, and elasticity in the microeconomy.